Question

1. The current market price of a firm’s common stock is $55 per share. The firm expects to pay a dividend of $4.10 at the end of the coming year, 2013.   Using the growth rate from question 4, calculate the required rate of return of this common stock assuming that the applicable tax rate is 21%.

2. A firm is wishing to calculate its cost of common stock equity by using the CAPM. The firm’s investment advisors and its own analysts indicate that the risk-free rate, R_f, is equal to 6%; the firm’s beta, b, is equal to 1.6; and the market return, r_m, equals 12%. What is the firm’s after-tax cost of common stock equity, if the firm’s tax rate is 40%?

3. A firm has decided to embark on new capital project. However, in order to start on the project the firm needs to issue new shares of common stock to raise the needed capital. The firm expects to pay a dividend at the end of 2013 of $5. The current market price, P_o, is $56 for the firm’s existing share of common stock. The firm has an expected growth rate of dividends, g, of 6%. The firm is estimating that the new shares can be sold for $52 with a $4-per-share flotation cost to be paid to issue and sell the new shares. Assuming that the firm’s applicable tax rate is 35%, calculate the cost of the new common stock.

4. The firm has the following mix of long-term sources of capital; 20% of long-term debt, 30% of preferred stock, and 50% of common stock equity. The firm’s before-tax cost of debit is 8.7%, the cost of preferred stock is 10.4%, and the cost of the common stock equity is 13.2%. Assuming that the firm’s applicable tax rate is 40%, what is the weighted cost of capital for this firm?

Answer 1

Question 1:
Growth rate from question is needed.
Question 2:
Cost of common equity per CAPM = rf+b*(rm-rf) = 6%+1.6*(12%-6%) =	15.60%
Question 3:
Cost of new common equity per DDM = D1/(P0-f)+g, where
D1 = next expected dividend, g = growth rate in dividends,
P0 = growth rate in dividends, f = flotation cost per share.
Substituting available values, Cost of new common equity =
= 5/(56-4)+0.06 =	15.62%
Question 4:
WACC = After tax cost of debt*Weight of debt+Cost of preferred stock*Weight of preferred stock+Cost of common*equity*Weight of common equity
= 8.7%*(1-40%)*20%+10.4%*30%+13.2%*50% =	10.76%